POISON PILL – A BOON OR A BANE TO SHAREHOLDERS?
“The Delaware Court of Chancery upheld Sotheby’s Board decision to implement Poison Pill to address shareholder activism”- May 2, 2014 Judgment
In Third Point LLC v. Sotheby’s, the activist hedge fund, Third Point LLC challenged Sotheby’s poison pill which effectively permitted passive stockholders to acquire up to 20 percent of Sotheby’s stock, whereas put a ceiling on the activist investors such as Third Point at a 10 percent ownership position. Third Point had claimed that by adopting a poison pill and refusing to waive the lower threshold of 10% for Third Point’s benefit, Sotheby’s directors had violated their fiduciary duties in order to gain advantage in a proxy contest with Third Point. The Delaware Court denied Third Point’s preliminary injunction to delay Sotheby’s annual meeting until a full trial was conducted on the validity of Sotheby’s poison pill. The Court recognized that a rapid accumulation of stock by an activist investor could result in control or negative control over a company and hence upheld Sotheby’s poison pill as a defensive measure.
However, a day before Sotheby’s annual meeting, the parties reached an agreement to settle their disputes. Both the parties agreed to add the three nominees proposed by Third Point to Sotheby’s board and to terminate the poison pill concurrent with the 2014 annual meeting. In addition, Third Point agreed to limit its equity ownership at 15 percent.
A “poison pill” is an effective defense mechanism available to publicly traded corporations. It is also known as “shareholder rights plan”. It is strategically designed to discourage hostile takeovers. By using a “poison pill”, the target company makes its stock extremely unattractive to potential acquirers, compelling them to negotiate a reasonable price with the target’s Board of Directors.
Typically when a Company realizes that there is hostile activity for takeover, the management decide to adopt a “shareholders’ rights plan”. The plan is structured in such a way that it gets triggered if any hostile bidder acquires say more than 15% of the firm’s outstanding shares. The triggering entitles shareholders to pay, for example one penny for 100 shares of the company’s stock. It is available only to those shareholders who held shares prior to the adoption of the plan. Thus, the company creates a pill that would immensely dilute the value of the stock in the event of a hostile takeover attempt.
Adopting a poison pill is not always favorable to the shareholders. In many cases, the shareholders feel that the takeover bid could be in their best interest; however, they do not always, have the right to vote on the bid. Consequently, the target companies have to decide if they should drop one of their most effective weapons against hostile takeovers to please their investors.
By creating a poison pill, a company can identify the beneficial acquisitions which could result in higher premiums being paid to the existing shareholders.
To adopt a rights plan, the Board of Directors is required to vote. Typically, the Board approves an issue of one right for each outstanding share of its common stock. Each right entitles the holder to purchase common or participating preferred stock of the company (“flip-in”) or common stock of the acquirer (“flip-over”) at a predetermined exercise price. However, such rights can be exercised only upon occurrence of certain events. The rights initially are attached to and traded with the company’s common stock.
Poison pills are extremely effective defense tactic. It helps a company not only to strike off unwanted takeover bids but also to find a more suitable acquiring party, a so-called “white knight.” Boards also favor poison pill for the power it brings during negotiation.
For example, in 2003, enterprise software giant Oracle attempted to acquire rival PeopleSoft through a $5.1 billion hostile takeover bid. But PeopleSoft’s poison pill was set to trigger if Oracle bought more than 20 percent of the company. After a year-long battle, PeopleSoft finally voided its poison pill and was finally acquired by Oracle for $10.3 billion — more than double compared to Oracle’s initial offer.
On the downside, the “Poison Pill” has the power to greatly reduce shareholder value.
For example, in 2008, Microsoft made an unsolicited bid for Yahoo. They offered shareholders of Yahoo, $31 a share representing a 62% premium at the time. However, Microsoft dropped the bid after the effect of the “Poison Pill” proved extremely difficult to handle. After Microsoft withdrew the bid, Yahoo’s stock price fell and did not trade anywhere close to $30 again.
Many companies do not have the choice of adopting the rights plan when it comes to big institutional investors. Market giant Fidelity Management & Research, for example, says that it “will generally vote against a proposal to adopt or approve the adoption of an anti-takeover plan.”
When poison pills were first put to use in the early 1980s, their legality was unclear. In Moran v. Household International, Inc, 1985, the Delaware Supreme Court upheld poison pills as a valid instrument of takeover defense. However, many jurisdictions other than the U.S. have held the poison pill strategy as illegal, or place restraints on their use.
At the end, it is difficult to judge the credibility of a poison pill. It really needs to be analyzed on a case by case basis.
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